When it comes to taking a road trip, would you prefer to steer yourself or let an autonomous car do the driving for you? It all depends on how much control you want over your ride. Similarly, the funds you choose to invest in offer different levels of involvement. But whether you pick more active or passive funds, you’re still on a journey toward your financial goals — just using different strategies to get there. Let’s go over some of the key differences between these two popular types of funds.
Expert Hands on the Wheel
An active fund is one that’s actively under the control of a fund manager. By carefully monitoring the fund’s performance and adjusting allocations, active funds try to outperform “the market.” Managers research the companies they’re considering investing in and analyze broader market conditions and trends to look for opportunities to boost returns. But a drawback of most active funds is that this expert management comes at a price — they tend to have higher fees than passive funds due to factors such as the expertise of the fund manager, the more frequent trading they perform and the extensive research and analysis involved. Moreover, active funds are typically less tax-efficient than their passive counterparts.
Putting Your Portfolio on Auto-pilot
Simply put, a passive fund isn’t actively managed. These funds are designed to closely track a particular index, such as the S&P 500 or the Russell 2000. By selecting an index fund, for instance, your investment aims to mirror the performance of its index, though it may not track it perfectly. But generally, when the index is up, your fund will rise in value, and when it’s down, your fund will lose value. Keep in mind that not all index funds are composed of stocks; there are also bond index funds, commodity index funds and other types, including index ETFs. Unlike index mutual funds, index ETFs can be bought and sold throughout the day.
Because passive funds require less oversight from fund managers and fewer transactions typically occur, fees tend to be lower than those for active funds. However, passive funds can also be vulnerable to market disruptions, as they lack the flexibility to react quickly to market changes. Even if you’re invested in index funds, you should still regularly monitor performance and periodically reassess whether the fund fits in with your overall financial strategy and risk tolerance.
A Financial Professional Can Help
Many funds offer diversification, but it’s crucial to review the specific holdings of the fund you’re considering. Whether your portfolio should skew toward active or passive funds is a decision that should be based on your goals, risk tolerance and how hands-on you want to be in your investment journey. With the help of a Financial Professional, you can decide the right strategy for you. The good news is that whether you keep your hands on the wheel or let your car drive, you can still ultimately reach your destination.
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